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January 14, 2011

To Rein In Inflation, China Tightens Reserve Requirements

Move push down stock, gold prices

In a continuing effort to reduce inflation and keep market bubbles from forming, China’s central bank on Friday raised required reserves for lenders for the fourth time in a bit over two months. The move was not without consequences on the world markets, as stocks fell, taking gold and other commodities with them. The euro fell, too, after first continuing Thursday’s gains against the dollar.

Chinese lenders must now maintain reserves of 19.5% on hand, an increase of 50 basis points, and while this is already a record high, a poll of economists in December by Reuters showed expectations that reserves will hit 20% by June.

Reuters reported that the action came as Beijing tried to stem the flow of rising prices and ward off social unrest. With the inflation rate at a 28-month high of 5.1% as of November, the costs of food and property are skyrocketing; China had repeatedly expressed concern over the possibility of a real estate bubble.

Beijing changed its monetary policy in December from “appropriately loose” to “prudent,” signaling more intensive efforts to control the effects of available cash. By compelling its lenders to lock up money in reserves, the nation hopes to ward off both inflation and asset bubbles, not just in real estate but elsewhere as well. Its efforts are expected to extend beyond reserve increases to interest rates, loan targets, and the yuan itself as the country tries to slow its raging economy.

World markets showed their concerns about a potential slowdown in growth fueled by China’s expanding consumer economy by the retreat of both stocks and commodities from steep Thursday gains. Investors have expected such actions from China, and indeed those actions display confidence on Beijing’s part in its own economy. However, the news was unsettling to those already displaying euphoria over the strong showing of euro zone bond auctions earlier in the week.

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